Views of William Nordhaus on Carbon Pricing
The following quotations are significantly incomplete.
William Nordhaus is the President of the American Economics Association and the Sterling Professor of Economics at Yale University. He has been publishing papers on climate change since 1977.
Summary of Carbon Pricing Views
“Climate change is a member of a special kind of economic activity known as global public goods.” To solve this problem, “At a minimum, all countries should agree to penalize carbon and other GHG emissions by the agreed upon minimum price.”
“Some countries might simply use carbon taxes. Others might implement their commitment using a cap-and-trade mechanism.” … “The best mechanisms for the encouraging of participation of low-income countries would be a combination of financial and technological assistance …”
2015-01 Nordhaus, William. “Climate Clubs: (30 slides) Presidential Address to the American Economic Association.
2015-01 Nordhaus, William. “Climate Clubs: Designing a Mechanism to Overcome Free-riding in International Climate Policy, (49 pp.) Background paper for the Presidential Address to the American Economic Association.
2008-06 Nordhaus, William. A Question of Balance: Weighing the Options on Global Warming Policies, (256 pp.) Yale University Press.
2005-12 Nordhaus, William. “Life After Kyoto: Alternative Approaches to Global Warming Policies,” (32 pp.) NBER Working Paper, number 11889.
1999-02 Nordhaus, William. “Requiem for Kyoto: An Economic Analysis of the Kyoto Protocol” (46 pp.)
1998-07 Nordhaus, William, “Is the Kyoto Protocol a Dead Duck? Are There Any Live Ducks Around?” Working Paper (summary only), Department of Economics, Yale University, 31 July.
1977-02 Nordhaus, William “Economic Growth and Climate-02: The Carbon Dioxide Problem,” (6 pp.) The American Economic Review, Vol. 67, No. 1.
Fundamentals of Global Carbon Pricing:
1. The International Climate Problem Is a Free-Rider Problem
Climate change is a member of a special kind of economic activity known as global public goods. … There are at best weak economic and political mechanisms for resolving these issues efficiently and effectively. … examples are national defense, public health, intellectual property rights, international trade, macroeconomic stability, fisheries, international environmental issues, endangered species, and transnational terrorism. ||| To the extent that an economic rationale lies behind the U.S. rejection of the Kyoto Protocol, it comes from estimates that the U.S. will bear a disproportionate share of the burden of adjustment and that the costs to the U.S. of the Kyoto Protocol far outweigh the benefits.
Under international law as it developed out of the 1648 Treaty of Westphalia and evolved in the West, obligations may be imposed on a sovereign state only with its consent. In other words, there is no legal mechanism by which disinterested majorities of countries can coerce free-riding countries into mechanisms that provide for global public goods. ||| For economic public goods, there are three potential approaches: command-and-control regulation, quantity oriented market approaches, and tax or price-based regimes. Of these, only the tradable-quantity and the tax regimes have any hope of being reasonably efficient. [2005-12]
2. A Global Carbon Price Is Needed
… Price or tax mechanisms. A radically different approach is to use harmonized prices, fees, or taxes as a method of coordinating policies among countries. ||| For concreteness, I will discuss harmonized carbon taxes (HCT). [2005-12]
3. Cap-and-Trade Can Comply
“At a minimum, all countries should agree to penalize carbon and other GHG emissions by the agreed-upon minimum price. … Some countries might simply use carbon taxes. Others might implement their commitment using a cap-and-trade mechanism … Yet another approach would be a hybrid cap and trade with a minimum price floor.” (The Climate Casino, 2013-10)
4. Green Fund Transfers Are Essential
Any climate-change regime must face three fundamental questions – the level of emissions reductions, the distributions of emissions reductions across countries, and the need for transfers to induce low-income countries to participate. [2005-12] The best mechanisms for the encouraging of participation of low-income countries would be a combination of financial and technological assistance in adopting low-carbon technologies as well as a campaign to substitute carbon taxes for other taxes. [2013-10]
1. A Price Simplifies Negotiations
A key point to recognize is that negotiating the minimum price would be much simpler compared to negotiating a complete set of individual national emissions caps. The simplicity of a single carbon price compared to country-specific emissions caps is an important but elusive point. It can be illustrated with the example of negotiations over dues to a club. Suppose that several people want to set up a club— for golf, cricket, or duck hunting. People differ in their enthusiasm, proximity, family size, and income. One approach is to negotiate dues on a member-by-member basis, where each member would have a certain share of the total. This procedure would require a long and painful negotiation over shares. There may be clubs that negotiate dues on a member-by-member basis, but I have never seen one in operation. This is the approach of the Kyoto model, and you can see why it is has proven so difficult and eventually fruitless. Negotiating a single minimum price would be much easier than negotiating emissions quotas. [2013-10]
2. A Global Price Provides a Countervailing Force against Free Riding
3. The Benefit of a Focal Point
Looking at the varieties of global public goods, I want to focus on those that I will call economic public goods. These activities are ones involving huge numbers of economic agents in a large number of countries where the costs and benefits of action do not indicate any obvious focal policy or technological fix. The opposite of economic public goods is focal public goods, where good policies appear obvious or consensual to most people, such as no AIDS, no smallpox, no financial collapses, no nuclear meltdowns, no nuclear explosions, and no trade barriers.
With economic public goods, it is usually difficult to determine and reach agreement on efficient policies because they involve estimating and balancing costs and benefits, where neither is easy to measure and both involve major distributional concerns. Economic public goods include such examples as … pollution (where most everyone agrees that zero pollution is prohibitively expensive). … There is a temptation to redefine economic public goods as focal public goods because that tremendously simplifies analysis and policy. [2005-12]
4. Why Caps Appear Unfair to Poor Countries
Quantity limits are particularly troublesome in a world of growing economies, differential economic growth, and uncertain technological change. These problems have become evident under the Kyoto Protocol, which … used baseline emissions from twenty years before the control period. … The 1990 base year penalizes efficient countries (like Sweden) or rapidly growing countries (such as Korea and the United States). It also gives a premium to countries with slow growth or with historically high carbon-energy use (such as Britain, Russia, and Ukraine). … The natural baseline, were it feasible to calculate, is the zero-restraint level of emissions. That level is in practice impossible to calculate or predict with accuracy, particularly when abatement policies are in place. … Under a price approach, the natural baseline is a zero-carbon-tax level of emissions, which is a straightforward calculation for old and new countries (more on this below). Countries’ efforts are then judged relative to that baseline.
5. International vs. National Cap-and-Trade
If carbon prices are equalized across participating countries, there will be no need for tariffs or border tax adjustments among participants. [2005-12]
The major obstacle to enforcement [of a tax] is the measurement of “net carbon taxes.” suppose that Germany imposed a $50 carbon tax, which would fall primarily on coal. It might at the same time increase its coal subsidies or reduce its gasoline taxes to offset the carbon tax. … the levels of taxes and subsidies are generally public knowledge, particularly in market democracies, where they are part of the legislative process.
3. Uniformity of the Global Price
4. Hitting a Target with a Price
Global emissions in 2010 under the current Protocol are estimated to be 1½ percent lower than a no-controls scenario if the new forestry offsets are ignored. ||| In practice, the tax might be set by aiming to limit GHG concentrations or to keep temperature changes below some level. [2005-12]
5. The Cost of Pricing is Low
6. The Use of Carbon Revenues
7. How to count exiting carbon taxes
… counting pre-existing taxes as compliance is appropriate and is easily seen as such in the carbon-tax framework. It makes no sense for countries with high existing taxes to add further penalties on top of existing ones before countries with subsidies or no penalties impose their carbon taxes. Therefore, the first step, and one absent from analysis of the Kyoto Protocol, would be a calculation of existing equivalent carbon taxes and subsidies. Our data suggest that, even without its CO2 taxes, Europe is taxing carbon at a rate of approximately $100 per ton carbon more than the United States.
8. Who Should Initiate the Treaty?
1. Price Volatility
Quantity-type regulations are likely to show extremely volatile prices. Such rapid fluctuations would be extremely undesirable, particularly for an input (carbon) whose aggregate costs might be as great as petroleum in the coming decades.
2. International Wealth Transfers
The transfer mechanism under a quantity approach takes place through the allocation of baseline emissions. … it is inconceivable that the United States would agree to the enormous resource transfers to Russia and other countries that are envisioned by the Kyoto Protocol. ||| Poor countries might receive transfers for early participation. [2005-12]
One of the subtle and overlooked problems with quantity-type systems is that they are much more susceptible to corruption than price-type regimes. … A price approach gives less room for corruption because it does not create artificial scarcities, monopolies, or rents. There are no permits transferred to countries or leaders of countries. The dangers of quantity as compared to price approaches have been shown frequently when quotas are compared to tariffs in international trade interventions.
Such cheating will probably be pandemic in an emissions-trading system that involves large sums of money. There are very poor intrinsic incentives for honesty in a cap-and-trade system. The purchasing unit gets a permit whether or not any true reductions take place by the selling unit. Emissions evasion has even worse incentives than tax evasion. Unlike the emissions-permit case, the recipient of the tax wants the payer to dispense the funds just as much as the taxpayer dislikes dispensing the funds. Tax cheating is a zero-sum game.